Future Returns: Investing to Minimize Water Risks

A boat makes its way along the Atchafalaya River in the Atchafalaya Basin, Charenton, La., the largest wetland and swamp in the United States. The river basin is under threat from sedimentation, as well as logging and gas drilling, says the nonprofit Atchafalaya Basinkeeper.
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As investors become more concerned about the impact the companies they own are having on the world’s water resources, they are designing ways to track and limit their exposure to water risks.

Often this involves knowing whether a company does business in a water-stressed region, such as areas of North Africa or the Middle East where the water can literally run dry. Or it can mean learning more about a company’s practices to ensure their operations aren’t degrading water supplies.

Institutional investors, as well as individual investors—on their own, or through investment advisors—“are increasingly seeing material impact to a particular holding, or they can see the risk and they are concerned about it,” says Monika Freyman, director, investment engagement, water at Ceres, a nonprofit investor group focused on sustainability issues.

ACTIAM, a Dutch investment manager with €54.6 billion (US$60.1 billion) in assets under management—and with a focus on responsible investing—is pushing the envelope on this work by aiming to have a “water-neutral” portfolio by 2030. To get there, they are working with the companies they own to ensure they are using water sustainably—so that it can be replenished naturally—and that they are not polluting or otherwise harming water resources in the course of doing business.

“This means promoting strong, regionally appropriate water management strategies by its portfolio companies, and transparent reporting of relevant water metrics,” according to a Ceres case study.

While ACTIAM has made the “biggest and boldest” public statement on the importance of assessing water risk, Ceres is working with many other institutional investors on what is known as investment water footprinting analysis, that is, a way of determining whether a portfolio holds individual stocks that present water risks, or a number of stocks in industries that tend to be problematic.

Wide Exposure to Water Risks

One “quick and dirty” analysis Ceres conducted looked at where water was a relevant investment factor across different industries, and then determined the exposure major investment benchmarks had to these sectors, Freyman says.

Industries such as oil-and-gas, semiconductors, and chemicals can have “water intensive operations and are likely to affect the quality and quantity of local water resources,” Ceres said in this analysis. Industries such as electric utilities, metals and mining, and beverage also tend to use high volumes of water, although company disclosure on this factor, particularly for smaller companies, isn’t always adequate, Ceres found.

The nonprofit then analyzed the water-risk exposure to these industries within the S&P 500, MSCI Emerging Markets, MSCI World, and the Russell 3000.

“Over half the holdings (across all four benchmarks) were in medium-to-high material water-risk industries,” Freyman says. “It's a big chunk of change.”

That means a lot of investors are broadly exposed to industries with high-water depencies or risks, Freyman says. Investors “are increasingly seeing it’s not a small subset of companies, it's potentially a large subset of companies.”

Freyman spoke to Penta about how investors can do their own water risk assessments. One way to start is with an Investor Water Toolkit the nonprofit developed with 40 institutional investors.

Filling the Information Gap

Institutional investors have more resources at their disposal, including, often, the ability to speak directly with corporate executives. But the toolkit, which is free and publicly available, is one resource available to individuals, as is Feeding Ourselves Thirsty, a report Ceres does every other year on water risks and company performance within the food and agricultural sector. The report ranks 42 companies within four sectors on how well they manage water resources within their businesses.

Investors can also consult CDP’s water security project, which compiles corporate disclosure of water risks and offers rankings of companies on the quality of their disclosure. The international nonprofit is driving companies, especially those in high-water risk sectors, “to be transparent about how they are managing water, and reporting to investors,” Freyman says.

Currently it’s a challenge for investors to know whether or not companies are masking their true water impact, but institutional investors, including asset managers, are increasingly asking probing questions of management. That’s not only for altruistic reasons, but because companies that don’t manage their water risks appropriately can run into trouble.

“It’s not just about a slow rising of the price of water, it's about massive mining companies—their operations being halted—or a power utility has to stop operating because they don't have the right water supply anymore,” Freyman says. “There are often big, operational or top-line risks that occur from water.”

What ACTIAM is Doing

As a guideline, it’s helpful to understand what the Dutch asset manager has undertaken to limit its water risks. It started by calculating the “water footprint” of its various investment funds—a measure, currently, of water use in high-risk areas by all of its portfolio companies. According to a Ceres case study, calculating the water footprint involves, among other details, assessing how much water is consumed by business activities in areas where there is a high level of water stress.

ACTIAM can tell investors, for instance, that the water footprint in its equity emerging markets index fund is 14,800 cubic meters. This is a rounded “absolute extraction of water from water scarce areas by companies in the fund, allocated to the weight of the investment that we hold,” says Maxime Molenaar, the firm’s responsible investment officer.

The asset manager incorporates its water analysis into its overall approach to achieving broader sustainability goals. “Ultimately we want to see the companies that we invest in change so that there’s effect in the real economy, not just in our portfolios,” Molenaar says.

Future Returns: Investing to Minimize Water Risks

As investors become more concerned about the impact the companies they own are having on the world’s water resources, they are designing ways to track and limit their exposure to water risks.

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